August 09, 2009

The Indian Government's Reaction to Satyam -- Marching Backwards to the Future

In what is still the global-scale financial scandal of the year -- India’s Satyam Computer Services -- the search for villainy continues to diversify.

• Blogger Francine McKenna leads the charge (Re:The Auditors) against what she sees as a corrupting business relationship of services provided alongside PricewaterhouseCoopers, whose Indian firm did Satyam’s audits.

• Indian regulators are publicizing their cooperation with the US SEC (here), and suggesting the imminent end to their investigations (here).

• And the amount of impartiality expected from the Indian system of criminal justice was signaled in the July 9 statement of Corporate Affairs Minister Salman Khurshid, that “All the concerned persons have been arrested except one and prosecution has begun against the guilty" (here, and the anxious emphasis is mine).

I was recently berated by a reader for saying back in February (here), that the Indian approach of incarcerating suspects even before charges were brought did not accord with basic notions of fairness and due process. The gist of his barb was that I was being “holier than thou,” because in his view the US government bail-out of its financial institutions was the “crime of the century,” whereby the “biggest crooks in our society” have stolen $ 700 billion of taxpayer money with no benefit to “the people who have landed on the streets due to foreclosure.”

My deeply insulted critic is entitled to his position. But he is trying to pick a fight on the wrong ground. I have lived and worked outside the US long enough to recognize the risk of presumptive cross-border judgments. And history, not he or I, will judge the leadership of President Obama, Treasury Secretary Geithner and Federal Reserve Chairman Bernanke. It’s not an “either/or” proposition.

Rather, it remains that, save for those like Alan Stanford who present flight risk, and where even the now-jailed Bernard Madoff enjoyed the liberty of his apartment until the day of his guilty plea, it offends mature notions of justice to imprison white-collar accused ahead of an adjudication of their guilt.

Pass this as a quibble. It is of more importance to the evolution of the Indian environment, that the degree of insight and perception shown by Minister Khurshid ominously suggests two reasons why the only impact of Satyam on that country’s governance and regulation will be from the “law of unintended consequences.”

The first issue is attitudinal. Satyam represents India’s “Black Swan” moment, in the phrase made popular by Nassim Nicholas Taleb’s best-seller (reviewed here). It was an unexpected and highly disruptive event – about which Khurshid commits the familiar error of misperception and flawed analysis, stating that “the Satyam scam is an aberration and the events are specific to the company in question. No other scam of this nature has come to notice since then” (here).

Now that Satyam has brought it forcefully home that large-scale corporate fraud is a reality in India (and in fact was completely predictable all along, despite official denial and evasion), it is equally certain that other similar situations are gestating even now, undiscovered but waiting their own moments to emerge.

So rationalizing Satyam as unique will be to miss the inevitable crises of the future. Yet, Khurshid’s remarks indicate a simple-minded determination to replicate the ineffective reactions of his counterparts in countries elsewhere.

That is, his view that a package of new legislation and an “elaborate regulatory framework” will address “all issues” involving forgery and computer manipulations, disclosures to stakeholders and discipline of public accountants and corporate secretaries (here) simply lacks the credibility of a track record of success.

Did Sarbanes/Oxley impede the credit market implosion? Or slow down Bernard Madoff? Measured against efforts at prevention, in jurisdictions suffering decades of corporate malfeasance and failing consistently to stop the periodic eruption of fresh cycles of wrongdoing, the Indian view that effective prevention can be learned and implemented from a one-off experience is dangerously naïve.

Secondly, even less likely to act as a deterrent is Khurshid’s proposal to include the concept of shareholder class actions in a new Companies Bill (here).

Events may well outrun the Indian legislators. As announced (here), the opportunistically-named Midas Touch Investment Association seeks to launch a class action in India on behalf of 300,000 shareholders, seeking over $ 1 billion from Satyam’s directors, auditors and promoters. At the very least, this promises a two-ring circus as veteran plaintiffs’ lawyers in the already-pending US actions will eagerly protect their access to an expected honeypot of legal fees.

Lest I attract further vitriol from those taking positions on either end of the advocacy spectrum – as to whether class actions are either a vital and essential weapon for defrauded investors, or a tool of extortion and destruction held over corporate management and a menace to the entire capitalist system -- a middle course:

Decades of American experience with securities class actions would suggest caution, before introducing such a jurisprudential tool into the kit of Indian governance and enforcement. At least, the empirical observation of developed economies and markets in Europe, which have thrived without the common resort to shareholder class actions, might at least indicate that steering the Indian system in the direction of the American would invite the re-invention of a set of less than desirable problems.

An available lesson from Taleb’s “Black Swan” is the all-too-human tendency to resist learning from failure. A special version – characteristic of the political classes and fully displayed by Minister Khurshid – is the hubris of the uninformed, who in their refusal to study the lessons of history are incapable of appreciating the boundaries of their ignorance.

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